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Sunday, September 16, 2012

Inflationary pressures on Nepali economy

Steep inflation and mounting food prices will leave a big dent in Nepalis' wallets this festive season

In its its latest annual macroeconomic update, the central bank estimated inflation to be at 8.3 per cent, higher than the seven per cent target set in the budget and monetary policy for 2011-12. Nepalis who are struggling to cope with rising prices, especially food prices, find this figure hard to digest. Inflation is eroding people's purchasing power, who spend around 65.1 per cent of their consumption expenditure on food, and is hitting low income earnersthe most.

The central bank's figure is low because it gives 46.82 per cent weight to food prices and 53.18 per cent to non-food and services prices while determining inflation, which means that non-food prices have more influence on inflation. Such practice is inconsistent with a recent research that that shows hike in food prices contributes about three-fourths of overall inflation.

The price movements, especially of food items, in the huge informal economy and the current debatable weight given to food and non-food items mean that official inflation figures underestimate the actual prices people pay in the market every day. The central bank's figures which show a decline in food and beverage inflation from 14.7 per cent in 2010-11 to 7.7 per cent in 2011-12 do not reflect reality.

Prices in Nepal have historically moved in tandem with prices in India, thanks to our pegged exchange rate and huge volume of imports. About one-third of price variability here is determined by prices in India. After 2007-08, when the global economy was struck by food, fuel, and financial crises, prices in Nepal started to remain stubbornly sticky at high level. It showed one directional changes only in response to food production and availability domestically, ie when supplies went down, prices went up. But when supplies moderated, prices remained sticky at high level. What happened?

As monetary policies (money supply and interest rate) have little traction on inflation in Nepal, supply side constraints and oil prices are weighing heavily on food and non-food prices. Since aggregate consumption has always been high (about 90 per cent of GDP) for a long time, there is very little extra pressure coming from demand side. Major pressure is exerted by supply side factors along with unjustified price speculation and rigging of product and factor markets by middlemen.

First, some wholesalers have deliberately withheld stocks to bump up prices in order to earn abnormal profits on the eve of Dasain and Tihar when the demand for essential food and non-food items is pretty much price inelastic (demand hardly changes with respect to changes in prices).

Second, though recurrent bandas temporarily disrupted distribution of essential items, wholesalers and retailers capitalised on the strikes to stick to higher prices even after the normalisation of supplies. Third, middlemen are distorting prices and calculatingly keeping them high. For instance, transportation cost and some leakages do not fully justify more than 50 per cent increase in prices of fruits and vegetables after they reach Kalimati from Dharke of Dhading. Powerful politically affiliated middlemen and associations act both as monopsonists (only they purchase food from farmers), and monopolists (only they sell food to wholesalers), in effect depriving farmers of the true price by stifling competition and also burdening consumers with artificially inflated prices.

Fourth, each time supply disruption occurs and oil prices are raised, there is inflationary expectations in the market, especially among retailers who preemptively up prices and keep it higher than the norm of taking 10 to 20 per cent profit only.

Fifth, the frequent hike in fuel prices and load-shedding hours have increased cost of production, which are ultimately reflected in the retail prices. Such fluctuations affect costs at production site, distribution chains, and retail stores. Furthermore, the continually rising imports of goods, especially those from outside of India, and the depreciation of the Nepali rupee have further pushed up prices.

Now, what can the government do about this?

For imported goods, there is little it can do to influence prices because they are determined externally. For those goods produced and sold domestically, especially food items, there is no other option but to strictly supervise distortionary activities by the movers and shakers of the market. It means clamping down on middlemen, setting up fruit and vegetable wholesale markets in strategic shopping locations, monitoring retail prices, and booking those who deliberately withhold supplies against the existing supply policies. Furthermore, the government could also lower import tariffs on food items, raw materials, and intermediate goods.

About

Formerly, economics officer at Asian Development Bank, Nepal Resident Mission. Worked as a researcher at SAWTEE, Kathmandu. Also, worked as a consultant for Ministry of Commerce & Supplies, Government of Nepal; FAO; UNDP, GIZ-CIM, and ADB among others. I was an op-ed columnist for Republica between December 2008 – June 2012. I also worked as a Junior Fellow for Trade, Equity & Development program at Carnegie Endowment for International Peace, Washington, D.C .